Leaseholders considering enfranchising the freehold of their flats are often unsure how the premium to purchase the freehold will be calculated. This is not surprising, as the legislation that sets out how the premium is calculated is complex, and has to be understood in the light of the various previous tribunal and court decisions that inform how the legislation is interpreted. This article will attempt to explain, in plain English, how freehold enfranchisement premiums are calculated.
Under the Leasehold Reform, Housing and Urban Development Act 1993 leaseholders have the right to collectively purchase the freehold to their building. The basis by which the premium is calculated is contained in Schedule 6 of the Act. The premium payable has three potential elements set out under paragraphs 3 (the value of the freeholder’s interest), 4 (freeholder’s share of marriage value) and 5 (compensation for loss resulting from enfranchisement) of Schedule 13.
The value of the freeholder’s interest
Under paragraph 3 the freeholder must be compensated for the value of his interest in the property. In the majority of cases the value of the freeholder’s interest will have two elements; the present value of any ground rent reserved under the lease and the the freeholder’s right to take possession of the property for an additional 90 years.
Freeholder’s share of marriage value
Under paragraph 4 where the unexpired term of the subject lease at the valuation date is greater than 80 years no marriage value is payable. Where the unexpired term of the lease is below 80 years marriage value is calculated on the assumption that the lease will be extended after the freehold is acquired, by subtracting the aggregate value of the freehold and leasehold interests before the lease extension from the aggregate value of those same interests after the lease extension. Marriage value will be significant element of the premium, and becomes more significant the shorter the lease.
Compensation for loss arising from enfranchisement
Under paragraph 5 the freeholder can claim compensation for diminution in the value of other property owned by him arising from the grant of the new lease. In practice this is very rare, and won’t be applicable in most cases. In smaller blocks and period conversions development value will often arise from the potential to convert the roof space as an extension of the upper flat, to develop the basement as an extension of the ground floor flat, or to undertake alterations which would otherwise be prohibited by the leases.
In cases where there is latent development potential within the property further compensation will sometimes be due in the form of development value. In smaller blocks and period conversions development value will often arise from the potential to convert the roof space as an extension of the upper flat, to develop the basement as an extension of the ground floor flat, or to undertake alterations which would otherwise be prohibited by the leases. Compensation can fall due under either paragraph 3 or 4 depending on the length of the lease.
In practice, the approach to the calculating the value of the freeholder’s interest is well-established. The present value of the ground rent (the amount an investor would pay today in order to receive the rent in the future) is capitalised at an appropriate yield, called a capitalisation rate. The present value of the reversion (the amount an investor would pay today for the right to take possession of the property on expiry of the lease) is calculated with reference to another yield, called a deferment rate.
Calculating the sum payable in marriage value is more contentious. The calculation requires an estimation of the value of the property on a long (extended) lease, and on its current (short lease), on the assumption that the leaseholder has no rights to extend his lease. The latter is problematic, given that in practice comparable evidence in the form of sales where the leaseholder has no rights to extend are very rare. This is often a problem area when it comes to agreeing the premium.
Likewise development value can be difficult to agree. Whether there is anything payable at all can often turn on seemingly innocuous facts, such as the way in particular clauses in the lease are drafted. Similarly considerations such as whether planning permission can be achieved, and how much it would cost to undertake the envisaged development, can be contentious.
The approach to calculating the premium payable for a freehold enfranchisement is well established, but the inputs to that calculation can be complicated. While it is useful for leaseholders to understand the way in which the premium is calculated, in most cases professional advice should be sought from a Chartered Surveyor specialising in this area of valuation.